The case both for and against private markets
The case both for and against private markets, in particular for high net worth investors (HNWIs), has been raging for some time and long may it continue to do so. This debate explains one reason HNWIs have typically much less exposure to the asset class, but there has to be more to it than that.
After all, the institutional world, with its much higher allocation to private markets, is equally aware of this discussion. Individual investors’ perceived lower tolerance for illiquidity risk relative to institutional investors is an obvious additional factor.
Exploring this opens up a wider range of structural, economic, behavioural and investment-related factors that need to be addressed if one wants to see HNWIs have a higher overall allocation to private markets.
In UK wealth management businesses, private markets can be accessed by HWNIs via listed investment companies. However, as good as some of these vehicles are, they represent a tiny portion of the overall private markets industry: in the case of private equity, the market cap of the ITs in this sector is less than 1% of overall private equity industry’s AUM. Furthermore, they tend to exhibit high levels of equity correlation, as befits a listed share.
For HNWIs, there are regulatory barriers to investing in less liquid, non-retail investment structures to access private markets. However, to the extent that where appropriate such investors could, should and would invest in these structures, two significant changes may already be making it much easier.
The traditional route to private markets for HNWIs is via the typical “vintage LP” closed-ended episodic fund raise structure. These will involve time-limited subscription periods, a capital commitment which is then drawn down over several years, usually stopping short of the entire committed amount. These vehicles’ lives can run to more than 10 years.
Relative to a public markets investment fund, they tend to be much harder for the investment adviser and the client to execute given the additional paperwork, compliance and suitability and appropriateness assessment required. Consequently, even some of the biggest HNWI investment advisers globally still find their average HNWI client has a lot less exposure to private markets than their own advice suggests they should have.
There are two big changes in the industry that may make it easier for both investment advisers and clients alike to reach their agreed target allocation to private markets over time. Firstly, the emergence of open-ended evergreen structures. These are usually fully funded from day one, meaning there is no need for capital calls and there is no J-curve and much less cash drag relative to traditional vintage programmes.
Whilst the IRRs will almost certainly be lower than a closed-ended LP equivalent, on a TWRR basis the investment returns between the two vehicles should be much closer. In short, the multiple of invested capital at the end of a ten year investment period may look quite similar. These vehicles also typically offer some liquidity but crucially often have fund-level maximum redemption limits.
This means that should an investor wish to redeem at a redemption window where the maximum redemption limit has already been breached, the investor may have to wait to get their money back. This risk must be clearly highlighted to clients.
Secondly, the development of a sophisticated platform ecosystem which helps HNWIs and their advisers access private markets in several ways. Each differs in their approach and relative strengths, but broadly speaking:
1) they provide pooled feeder funds to allow investors who would normally be too small for private markets managers to bother with access to the flagship funds by pooling their money with other relatively small investors to create one fund that the private market manager is happy to engage with;
2) offer technology to help with the additional compliance and operational aspects of investing in a less-liquid, non-retail investment structure, benefitting by the HNWI investment adviser and the client; and
3) investment advice where in-house private markets expertise is lacking.
Together, these developments help investment advisers help their HNWI clients to get to their target allocation to private markets which might have been harder if simply trying to directly access traditional vintage programmes. They don’t have to be either/or routes.
To the extent that a HNWI private markets offering needs to reflect some client segmentation by size or sophistication, one route might be more suitable for some clients than others, meaning advisers need both in their tool kit to serve different client types. It is equally easy to envisage both being utilised by the same client.
However, at the heart of private market access for HNWIs will always be suitability and appropriateness. Investment advisers must have a robust process for properly assessing 1) whether less-liquid, non-retail private markets structures are suitable and appropriate for each individual client and 2) what a suitable and appropriate private markets allocation may look like for each individual HWNI.
New fund structures and platforms may be game changers, but the vitality of both the investment case and relevance to meeting clients’ investment needs remains paramount.
Don’t invest unless you’re prepared to lose all the money you invest. This is a high-risk investment and you are unlikely to be protected if something goes wrong.
Andrew Summers, Head of Alternative Investments Investment & Research Office, Investec Wealth & Investment is part of our incredible IMpower 2023 speaking faculty. Don't miss out on his session 'How to achieve the same access, oversight, liquidity and transparency for private market products as normal equities' on the 27th of June 2023.
Find out more about IMpower 2023 here >>
